The Role Of Internal Transfer Pricing In The Aggregates Industry.
By Barry Hudson
Many aggregates companies operate across multiple business units – quarries, transportation, concrete, asphalt and sales divisions – each responsible for different parts of the value chain. Internal transfer pricing determines the cost at which materials move between these divisions before reaching the final customer.
When set incorrectly, these transfer prices create a ripple effect that distorts external selling prices. The consequences range from squeezing profit margins to losing out on contracts due to uncompetitive pricing.
Common Internal Transfer Pricing Methods in Aggregates
1. Cost-Plus Pricing. A production cost is determined, and a fixed margin is added to set the transfer price.
2. Market-Based Pricing. The transfer price is set based on comparable market prices for similar products.
3. Negotiated Pricing. Different business units agree on a transfer price that balances internal costs with profitability targets.
Each method has its risks, and when applied incorrectly, it can lead to severe pricing issues externally.
The Hidden Risks of Poor Internal Transfer Pricing
1. Underpricing Internal Transfers Selling Below Market Rates
One of the biggest mistakes companies make is underpricing materials when transferring between divisions. If a quarry sells aggregates to its own sales division at an artificially low cost, the final external price may also be too low, eroding profitability.
Example: The Self-Inflicted Price War
A European aggregates company, in an effort to boost its sales division’s margins, priced its internal transfers at below-market rates. The sales division, seeing high profit margins, aggressively undercut competitors in the external market.
At first, this led to increased volume sales. However, competitors soon retaliated by lowering their prices, leading to a market-wide price decline. The company found itself locked in an unsustainable pricing war, where even high volumes could not offset shrinking margins. The end result? The entire market suffered from price compression, and profits across the industry were reduced.
2. Overpricing Internal Transfers Uncompetitive External Pricing
On the other end of the spectrum, some companies inflate internal transfer prices to boost reported profitability in one division – soften in response to internal financial targets or tax structuring strategies.
Example: Losing Contracts Due to Pricing Blind Spots
A major North American aggregates producer applied a high internal transfer price to materials sold by its quarries to its distribution division. This inflated the cost basis for the final sales price. While competitors were selling crushed stone at $12 per ton, this company’s sales team had no choice but to price at $15 per ton just to cover internal costs.
Unsurprisingly, customers chose competitors instead. The company lost major contracts, and despite excellent operations, its external pricing made it uncompetitive.
3. Transfer Pricing Discrepancies Causing Regional Price Distortions
When internal transfer pricing is inconsistent across locations, companies can end up with wide pricing disparities between regions. This confuses customers and disrupts market pricing dynamics.
Example: The Regional Price Gap That Led to Arbitrage
A multinational aggregates company set different internal transfer prices for materials based on regional cost structures. However, this led to significant price gaps – customers in one region paid $10 per ton, while another region was charging $14 per ton for the same product.
The unintended consequence? Customers started sourcing materials from the lower-priced region and transporting them to higher-priced areas, creating an arbitrage opportunity that undermined the company’s own pricing strategy.
Three Key Data Points on Internal Pricing & External Pricing Impact
1. Material Costs vs. Market Prices
- In a study of 20 aggregates firms, firms that set internal transfer prices within 5% of market rates were 30% more profitable than those with larger deviations.
- Firms that underpriced internal transfers had external price reductions of 7-12% due to artificially low margins.
2. Impact of Overpricing on Market Competitiveness
- A major North American aggregates producer saw a 15% drop in sales volume after raising internal transfer prices, making its external prices uncompetitive.
3. Regional Price Variability & Customer Behavior
- Inconsistent internal transfer pricing led to up to 20% regional price differences, causing customer sourcing shifts that reduced overall revenue.
Why Internal Transfer Pricing is a Key Tool in External Price Setting
Done correctly, internal transfer pricing provides a clear, accurate cost basis for external pricing decisions. It allows companies to:
1. Ensure Profitability at Every Stage. Proper transfer pricing ensures that no division is subsidizing another, leading to sustainable margins.
2. Maintain Market Competitiveness. Avoiding price distortion ensures companies remain competitive without underpricing or overpricing.
3. Optimize Regional Pricing Strategies. Standardizing transfer pricing helps prevent regional arbitrage and inconsistencies.
4. Meet Regulatory & Tax Compliance. Proper internal pricing reduces audit risks and regulatory scrutiny.
Get Transfer Pricing Right and External Pricing Follows
Internal transfer pricing isn’t just an accounting exercise – it’s a foundational pillar of effective external pricing. When done poorly, it distorts costs, skews market positioning, and creates ripple effects that impact competitiveness and profitability.
The aggregates industry already faces pricing pressures from competition, regulations and market fluctuations. The last thing companies need is self-inflicted pricing problems due to poor internal transfer pricing decisions.
By ensuring internal transfer prices reflect real costs and market conditions, aggregates companies can set rational, competitive external prices that protect both market share and margins. The smartest companies in the industry already know this – and those that don’t risk learning the hard way.
For Reference
Price-Bee.com cannot use actual customer data due to confidentiality agreements. However, specific numerical examples were provided to illustrate the potential impacts of internal transfer pricing decisions on external pricing within the aggregates industry. These figures were hypothetical and intended for illustrative purposes, as precise data on internal transfer pricing practices and their direct effects on external pricing in the aggregates sector are not publicly available.
However, the broader implications of internal transfer pricing on external pricing have been documented in various industries. For instance, a report by the UK’s Competition Commission analyzed cost structures and profit margins in the aggregates sector, highlighting the importance of aligning internal transfer prices with open market rates to ensure competitive external pricing.
Additionally, the International Monetary Fund has discussed the risks associated with transfer pricing in extractive industries, noting that misaligned internal prices can lead to tax losses and market distortions.
While numerical data may be limited, these sources underscore the critical role of appropriate internal transfer pricing in maintaining fair and competitive external pricing strategies.
Barry Hudson is the co-founder of Price-Bee, www.price-bee.com.